Small pay rises

Scroll

Small pay rises can cause a huge unexpected tax bill for final salary pension scheme members: taking advice is crucial Many final salary pension scheme members are unaware that a relatively small pay rise could generate a large tax bill if it pushes you over your annual allowance.

Small pay rises can cause a huge unexpected tax bill for final salary pension scheme members: taking advice is crucial

Many final salary pension scheme members are unaware that a relatively small pay rise could generate a large tax bill if it pushes you over your annual allowance. This case study shows why expert financial advice is essential to help you navigate this pitfall.

When Kate first came to us, she was in her mid-50s and working for the NHS part-time.

Over the last few years, she had received small pay rises and increased her hours slightly due to Covid 19. That all seemed good from a financial perspective, until she became aware that the increases had sent her over the £40,000 pension annual allowance and landed her with a large tax bill.

Pension schemes often do not alert you to this problem and cannot give individual advice. So if you are in a final salary scheme, it is crucial to get advice from a pension specialist.

Furthermore, as Kate was unaware she had breached the annual allowance, this had not been declared on her tax returns. This led to a potential penalty and interest charges – another cause of great anxiety to her.

Kate wanted Blackstone Moregate to help her understand the implications of exceeding the allowance; whether she was likely to breach it again; how much the tax charges were; options for paying them; and the impact of each option to her personal financial goals.

Reducing the charge

Using our technical expertise, we calculated Kate’s unused allowances from previous years. This helped reduce her excess pension input by £28,000, saving a significant amount in tax. There was still, however, an excess totalling £65,000 for two tax years, leading to a large tax bill.

Kate was concerned because she did not understand the impact this would have on her rainy day savings, and the money she had set aside for much needed home improvements and to help her daughters through university from next year onwards.

Understanding and paying the charge

We explored the main alternatives with Kate, which were paying the tax through the scheme; requesting a partial payment; or paying directly in full.

For the first year, the deadline for asking the NHS pension to pay the charge had passed, meaning Kate had no option but to pay HMRC directly in full. To find the best option for the second year, we calculated how much the NHS pension would reduce her benefits to cover the charge; and the possible income if she instead invested the cost in the market.

We found it would take 24 years to repay the charge if paying through the scheme, and that the potential open market income did not match those potential benefits. Given that Kate’s life expectancy was well over 24 years, it was therefore more attractive to pay directly.

She was initially loath to pay directly, as it would dent her savings significantly. We then used cashflow modelling to show her that she could still achieve all her life goals and that that the financial impact of the reduced pension income was far greater over her lifetime. She would also receive a lump sum from her pension on retirement that would replenish her savings.

Lastly, given that Kate did not expect further pay increases before retirement, we confirmed it was unlikely she would breach the annual allowance again.

Peace of mind in retirement

The effect of our advice was that Kate understood the tax charges in relation to her NHS pension and was no longer worried. She comprehended the options for paying them, the best way forward, and the impact on her retirement planning.

Kate was reassured that she is unlikely to have another large tax bill before retirement. We continue to monitor her financial plan and are working towards her being able to retire comfortably in two years.

Working with a financial planner on an ongoing basis allows you to navigate such pitfalls with confidence, ensuring they do not impact your retirement finances and cause you undue stress. We showed Kate how to see through the fog and helped her take the best course of action. This allowed her to focus on the things that mattered to her such as family and work.

Although this case study showed that paying the tax directly was the best option, each person’s situation is very different, even in the same scheme. It is therefore vital that you take financial advice if you are in a final salary scheme.

If you are a member of a final salary pension scheme and would like a clear understanding of your current situation and how to achieve your goals, contact Blackstone Moregate on 020 3376 1444.

TESTIMONIALS

Kind words from our customers

Read all reviews

Apart from the courtesy and warm greeting I experience each time I speak or meet you or any of your team, I am always impressed by the level of knowledge...

Christian Stanley

I have been a client of Vijay Thakkar and Blackstone Moregate for over twenty years. Throughout this time they have carefully and sympathetically managed my small...

John Branscombe

We had a complex SIPP requirement involving multiple pension schemes and a joint property purchase. Our previous advisor had informed us that the chances...

Adrian Cowley

Get your Financial House in order